News Flash! The Bull Market Is Quite Rational

There’s a narrative that has emerged from some in the media suggesting that the current stock market seems irrationally complacent and unhinged from reality.

How else, it is argued, can the Dow Jones Industrial Average and the Standard & Poor’s 500 continue to toy with fresh all-time highs while newspaper front pages and cable news programs tell us that the Trump presidency is in disarray, perhaps even under the shadow of an impeachment.

Given such a backdrop, how can the major stock indexes, with their low volatility, fiddle while Washington burns?

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Anyone who poses such a question might naturally feel that it’s just a matter of time before the market wises up and corrects downward. But such thinking overestimates the role that political news has always played in impacting stock values and underestimates the role that unglamorous, less arresting financial and economic news plays.

Two recent columns make the point that the stock market’s seeming imperviousness to the daily political firestorms makes total sense when viewed through a historical lens. It’s probably more than a coincidence that both pieces were written by professionals in the asset-management industry, not journalists.

In a piece for Bloomberg View, Charles Lieberman, chief investment officer and founding member at Advisors Capital Management, writes that the investors are well aware of the political news, but know that it matters “only to the extent it undermines the ability of companies to grow.’’

“First and foremost, stock prices are driven by corporate profits,” Lieberman writes. “If businesses make more money, their shares will become ever more valuable. Thus, the 13.9 percent surge in first-quarter 2017 profits (the highest since 2011) despite a modest 0.7 percent expansion in gross domestic product demonstrates unambiguously that corporate operations are lean and highly leveraged to even small gains in the economy.”

As for the political news out of Washington, Europe, and even North Korea that has dominated headlines in recent weeks, Lieberman writes: “The truth of the matter is the global political scene has been awful for decades, even centuries. Was the global news flow any better around World War I? During the interwar years when inflation exploded in Weimar Germany, leading to the rise of Nazism? During World War II? During the Korea, Vietnam and Cold Wars? It doesn’t get any better if you go further back in history.”

He adds that “domestically, we had massive population shifts off the farm into factories early in the 20th century, followed by a Great Depression that elevated unemployment to 25 percent, recurring recessions in the 1950s after World War II, a surge in inflation to double digits, random crises that killed off the savings and loan industry, major failures in commercial real estate (causing Donald Trump, among other real estate tycoons, to suffer massive losses and bankruptcies), failing emerging-market debt, a residential housing crisis, and on and on.”

Lieberman points out that these aforementioned events “were real economic shocks that mattered vastly more to the equity market than the political battles that captured our attention, whether it was Jimmy Carter’s inability to get our embassy hostages out of Iran, the riots that occurred at the Chicago Democratic convention in 1968, Richard Nixon’s impeachment and resignation, Vice President Spiro Agnew’s resignation (to avoid impeachment), the Iran-Contra scandal, Bill Clinton’s Monica Lewinsky scandal, gridlock in Washington, some of which led to brief government shutdowns. …Yet, despite all of this political theater and violence, the U.S. economy has grown, living standards have increased, corporate profits have risen, and stock prices are rightfully at record highs because so are profits.”

In an op-ed column for the New York Times, Sharma writes the major stock movements throughout history haven’t been driven by political events unless they impact the corporate bottom line.

“In the United States, the stock market fell during the Watergate scandal but for reasons that had little to do with Richard Nixon and much to do with the stagnant economy and inflation,” he writes. “And stock prices rose steadily during the investigations and impeachment of Bill Clinton, until the 1998 collapse of the hedge fund Long-Term Capital Management threatened to trigger a global financial crisis. The same holds for other political scandals, like Teapot Dome and Iran-contra.”

His key point is that it’s a mistake to view the markets through an ideologically colored lens. And it’s a mistake that many likely have an easier time making in these politically charged times.

“I know plenty of right-wing ideologues who, convinced that President Barack Obama was leading America to ruin, missed out on the market’s long bull run,” Sharma adds. “Similarly many Democrats now think President Trump is taking the country down and assume that stock prices will follow.”

He concludes: “The stock market is best understood not as a presidential poll but as a barometer of the nation’s current economic mood, and it remains buoyant now for reasons unconnected to the White House.”

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